What is Tier 1 capital and what does it tell you about a banks health?
Tier 1 capital includes a bank’s common equity – the value of the shares it has sold to the public – plus the value of its non-cumulative preferred shares, and its retained earnings. These are instruments that can’t easily be redeemed by holders, so they are considered permanent. Tier 1 capital, as a proportion of a bank’s overall assets, is a key measure of its financial strength. There are international standards, set by the Swiss-based Bank for International Settlements, for this Tier 1 capital ratio. In Canada, the Office of the Superintendent for Financial Institutions sets the minimums. Most Canadian banks have Tier 1 capital ratios of around 10 per cent (meaning that Tier 1 capital represents about one-10th of overall assets), well above the OSFI minimum of 7 per cent. The banks also measure second level, or Tier 2, capital which includes not-quite-so-permanent items such as reserves, loan loss provisions, and subordinated debt.
